Banking Chapter 8-11

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What is the difference between moral hazard and adverse​ selection?

(Adverse selection) occurs when bad risks are more likely to​seek/accept a financial contract than are good risks. (Moral hazard) occurs in financial markets when borrowers use borrowed funds differently than they would have used their own funds.

What are the key differences between​ foreign-exchange forward contracts and​ foreign-exchange futures​ contracts?

(Forward) contracts are private agreements among traders to exchange any amount of currency on any future​ date, while (futures) contracts are traded on exchanges and are​ standardized, including a stated settlement date. With (futures) ​contracts, the exchange rate changes continually as contracts are bought and sold on the​ exchange, and with (forward) ​contracts, the exchange rate is fixed at the time the contract is agreed to.

Suppose that the U.S. firm Alcoa sells ​$3 million worth of aluminum to a British firm. If the exchange rate is currently $1.03=£1 and the British firm will pay Alcoa £2,912,621.36 in 90​ days, answer the following questions. 1.) What​ exchange-rate risk does Alcoa face in this​ transaction? 2) What alternatives does Alcoa have to hedge this​ exchange-rate risk?

1.) A falling British pound. 2.) all of the following Alcoa can sell currency futures. Alcoa can enter into a forward contract. Alcoa can buy options contracts. To hedge this​ exchange-rate risk, Alcoa can (sell 2,912,621.36) pounds for dollars at the forward rate to hedge the risk of the pound (falling).

The author of a newspaper article providing advice to renters observes that​ "landlords will always know more than you​ do." 1.) Do you agree with this​ statement? If​ so, what do landlords know that potential renters might​ not? 2.) If the statement is​ correct, what are the implications for the market for rental​ apartments? 3.) In what ways is the market for rental apartments like the market for used​ cars? 4.) In what ways is it​ different?

1.)Agree; Landlords know more about the quality of the​ property, and hence its true​ value, than renters. 2.)Landlords will attempt to charge a higher price than they otherwise would receive in the absence of this information asymmetry. 3.)In both​ markets, the owner knows more than the potential renter or buyer. 4.) The landlord is not selling the​ apartment, merely renting​ it, while the buyer of a used car makes an irreversible deal.

When was TARP​ created?

2008

What is the difference between a spot transaction and a forward transaction in the​ foreign-exchange market?

A (spot) transaction is trade today​ and a (forward) transaction is traded in the future.

All of the following are reasons why these financial foundations were important in making possible the rapid growth of the U.S. economy during the nineteenth and twentieth​ centuries, except:

A central bank provided direct control over all interest​ rates, facilitating the control and direction of the overall economy.

What is a junk​ bond?

A junk bond is a bond with (high default risk and a low credit rating). Investors have been willing to buy these bonds despite their low yields since they (offer higher interest rates than higher rated bonds).

If the exchange rate between the yen and the dollar changes from ¥92​= $1 to ¥86= $1, is this good news for​ Sony?

A yen appreciation is (BAD) news for Sony. This is (BAD) news for U.S.​ consumers, as Japanese goods become (MORE) ​expensive, and (GOOD) news for U.S.​ firms, as the dollar has (DEPRECIATED) against the yen. Because U.S. goods are now (LESS) ​expensive, this is (GOOD) news for Japanese consumers.

How are finance companies able to compete against commercial​ banks?

A. A lower degree of regulation allows finance companies to provide loans tailored to match the needs of borrowers more closely than do the standard loans that commercial banks provide. AND B. Finance companies have a small advantage over commercial banks in monitoring the value of​ collateral, which gives them an advantage in consumer​ durables, inventories, and business equipment.

​[Related to the Making the ConnectionLOADING...​] In​ 1960, federal regulations prohibited banks from paying interest on checking accounts.​ Today, banks are legally allowed to pay interest on checking​ accounts, yet the value of checking accounts has shrunk from more than​ 50% of commercial bank liabilities in 1960 to less than​ 12%. Because checking accounts now pay​ interest, shouldn't they have become more popular with households rather than less​ popular?

A. All else​ constant, this would increase the popularity of checking accounts.​ However, at the same time that interest became payable on checking​ accounts, banks were creating several new savings​ instruments, including certificates of deposit and money market deposit accounts. AND B. As wealth increases over​ time, households hold less money in checking accounts relative to other financial assets.

Is an investment bank that buys securities with its own capital acting as a financial​ intermediary?

A. An investment bank that buys securities with its own capital is not acting as a financial intermediary. AND B. By buying securities with its own capital the bank expects to get profit from the yield or the changes in price.

How might an investor use​ forward, futures, and options contracts to speculate on the future value of a​ currency? ​(Check all that​ apply.)

A. For forward​ contracts, if an investor becomes convinced that the future value of the euro will be lower than other people in the​ foreign-exchange market currently​ believe, the investor can sell euros in the forward market. and D. For​ options, if the value of the currency falls below the strike​ price, the firm could exercise the option and sell at the​ (above-market) strike price.

What is​ "Lehman paper"?

A. Lehman Brothers debt. AND B. Lehman Brothers commercial paper.

Which from the following are​ off-balance-sheet activities? ​(Check all that​ apply.)

A. Standby letters of credit. Your answer is correct. B. Loan commitment. Your answer is correct. E. Trading activities. Your answer is correct. F. Loan sales.

​"Insurance companies often suspect the only people who buy insurance are the ones most likely to​ collect." What do economists call the problem being described​ here?

Adverse selection. If insurance companies are correct in their​ suspicion, it will (INCREASE) the price of insurance.

​"A bank that expects interest rates to fall will want the duration of its assets to be greater than the duration of its liabilities​ - a positive duration​ gap." Do you agree with this​ statement?

Agree. A fall in interest rates with a positive duration gap will increase a​ bank's capital.

A column in the Wall Street Journal offered the opinion that​ "as a rule of​ thumb, the more complex a​ [financial] product​ is, the worse the​ deal." Do you​ agree? Why would a more complex financial product be likely to be a worse deal for an investor than a simpler​ product?

Agree. When investors buy simpler​ products, they typically have more information and can make more informed choices about the products.

​"A bank that expects interest rates to increase in the future will want to hold more​ rate-sensitive assets and fewer​ rate-sensitive liabilities." Do you agree with this​ statement?

Agree.​ Rate-sensitive assets will increase in value thus holding more of them as​ assets, while reducing them as​ liabilities, will increase bank profits.

Which of the following is a correctly explained key feature of the financial​ system?

All apply Loans from financial intermediaries are the most important external source of funds for​ small- to​ medium-sized firms. Financial intermediaries can reduce the transaction costs of borrowing for small firms. The stock market is a less important source of external funds to corporations than is the bond market. This is because there is less moral hazard involved with bonds than with stocks. Debt contracts usually require collateral or restrictive covenants. The purpose of the collateral is to reduce moral hazard.

According to a survey of professional​ foreign exchange traders, the theory of purchasing power parity is considered to be​ "academic jargon." Which of the following are reasons why​ foreign-exchange traders might not find PPP to be useful as they trade currencies​ day-to-day?

All of the following... 1. Day-to-day movements in currencies are driven by the news. Your answer is correct. ​2. Day-to-day movements in currencies are driven by​ short-term economic events. Your answer is correct. 3. ​Day-to-day movements in currencies can be driven by a large degree of random movements.

Why is the demand curve for foreign exchange downward​ sloping?

As the exchange rate​ falls, it becomes cheaper to convert a foreign currency into​ dollars, so there is a larger quantity of dollars demanded.

The key accounting equation on which balance sheets are based is given by

Assets​ = Liabilities​ + Shareholders' Equity.

Describe some of the information problems in the financial system that lead firms to rely more heavily on internal funds than external funds to finance their growth. Do these information problems imply that firms are able to spend less on expansion than is economically​ optimal?

Asymmetric information makes information costs for external funds higher than for internal​ funds, but these costs do not necessarily imply that firms are able to spend less on expansion than is economically optimal.

When a​ bank's capital​ improves, what must have happened to the value of the​ bank's assets relative to the value of its​ liabilities?

A​ bank's capital is defined as the value of a​ bank's assets (MINUS) the value of its liabilities. ​Therefore, if a​ bank's capital​ improves, we know that the​ bank's assets must have (RISEN RELATIVE TO) the value of its liabilities.

What is the difference between a​ bank's return on assets​ (ROA) and its return on equity​ (ROE)? How are they​ related?

A​ bank's return on assets​ (ROA) is the ratio of a​ bank's after-tax profit to the value of its assets. Return on equity​ (ROE) is the ratio of the value of a​ bank's after-tax profit to the value of its capital. ROE is equal to ROA multiplied by the ratio of bank assets to bank capital.

Suppose that Bank of America sells ​$30 million in Treasury bills to PNC Bank. Use​ T-accounts to show the effect of this transaction on the balance sheet of each bank.

Bank of America Reserves $30 Securities $-30 PNC Bank Reserves $-30 Securities $30

How do banks manage​ interest-rate risk? ​(Check all that apply.​)

Banks can reduce​ interest-rate risk by making more floating rate​ loans, or ARMs. and ​Interest-rate swaps can reduce​ interest-rate risk exposure.

What does it mean to describe deposit insurance as undermining "market discipline"​?

Because (MOST) depositors are fully​ insured, they have (LITTLE) incentive to withdraw their money and cause their bank to fail. This encourages (RISK-TAKING) by bank managers as depositors are protected (REGARDLESS OF) how the bank actually performs.

How does the lemons problem lead many firms to borrow from banks rather than from individual​ investors?

Because banks specialize in gathering​ information, they are able to overcome the problem of distinguishing good borrowers from bad borrowers. and Because potential investors have difficulty in distinguishing good borrowers from bad​ borrowers, they offer good borrowers terms they are reluctant to accept.

In the adjacent​ figure, countries that are above the upward sloping line have relatively high levels of real GDP per capita for their levels of financial development and countries that are below the line have relatively low levels of real GDP per capita for their levels of financial development. Holding constant all other factors that might affect a​ country's rate of economic​ growth, would we expect future growth rates to be higher for countries above the line or for countries below the​ line?

Below the line because these countries have underperformed so far given the strength of their financial system.

What risks were investors taking on by buying these​ bonds?

By buying these bonds investors take on (default risk) associated with the investment. Buying Ball Corporation bonds in 2020 also exposes investors to (interest rate risk since rates will likely increase in the future).

Which of the following might indicate that a currency is​ overvalued?

Central banks are buying currency on the open market.

​"If a bank manager expects interest rates to fall in the​ future, he should increase the duration of his​ bank's liabilities." Do you agree with this​ statement?

Disagree. Higher duration of its liabilities will reduce the value of the​ bank's capital.

The website of the CME​ Group, a market for trading derivatives​ contracts, includes the following​ observation: "A Eurodollar and a euro are not the same​ thing." What is the difference between Eurodollars and​ euros?

Eurodollars are dollar deposits in banks outside the U.S. while euros are the European​ Union's currency.

Suppose that the euro rises in value relative to the dollar. What is the likely effect on European exports to the United​ States? What is the likely effect on U.S. exports to​ Europe?

European exports will (decrease) and U.S. exports will (increase.)

In what sense might deposit insurance be considered a federal subsidy for​ banks?

FDIC insurance is backed by the full faith and credit of the United States government.

Despite these potential​ drawbacks, economists and members of Congress overwhelmingly support deposit insurance for all of the following​ reasons, except:

FDIC protects every dollar a customer has in a bank.

Why​ don't fintech firms rely only on FICO​ scores, as many banks​ do, when making​ loans?

FICO scores use (a handful of standardized measures) in determining default risk. Borrowers with (little to no credit history) such as (college students) will have misleading FICO scores and will be less likely to qualify for loans. This group of borrowers is likely to be (more) risky than borrowers with high credit​ scores, but lenders would like to accurately determine their default risk since they (can charge this group higher interest rates) than borrowers with high credit​ scores, and earn (higher) profits.

What are fintech​ firms?

Fintech is short for (financial technology.) Fintech firms are known for providing financial services (using innovative methods such as big data.)

Which of the following might explain why a country without a strong financial system would struggle to achieve high rates of economic​ growth?

Firms are unable to acquire funds they need to expand.

How can​ exchange-rate risk be hedged using​ forward, futures, and options​ contracts?

Firms can buy forward contracts to hedge against a rise in the exchange rate.

​[Related to the Apply the​ Concept: "What Explains Movements in the Dollar Exchange ​Rate?"​] In March​ 2020, as the​ Covid-19 pandemic began to have a significant effect on the global​ economy, an article in the Wall Street Journal discussed what was happening with the British pound. The article stated​ that: "The pound is being caught up more generally in a flight to dollars that is affecting all of the​ globe's major​ currencies." What does the article mean by a​ "flight to​ dollars", and how is it​ occurring?

Foreign investors are attracted to the stability of the U.S. dollar and decide to invest in dollar denominated assets such as U.S. Treasury bonds. \D1 \D2 D2 is above D1 intersect E2 The graph indicates that the flight to dollars results in (an appreciation of the dollar and a depreciation of the pound.)

Why are forward contracts more widely used in the​ foreign-exchange market than are futures​ contracts?

Forward contracts are used 10 times more than futures contracts because the counterparty risk between big banks is relatively (low)​, and these banks value the (flexibility) of the forward contract.

Why had the GSEs taken on too much risk prior to the​ 2007-2009 financial​ crisis?

GSEs took on risk as a result of trying to (achieve Congress' goal of increased home ownership). When GSEs are involved in the mortgage market​ banks, or other mortgage​ lenders, (pass the risk onto the GSEs) if borrowers fail to make payments on their mortgages.

Who would be interested in exchanging yen for​ dollars?

Japanese companies importing or buying U.S. products.

What is the argument in favor of believing that repealing the​ Glass-Steagall Act did not play a role in the financial​ crisis?

Large banks that combine commercial and investment banking activity were not at the center of the financial crisis.

What is the most important source of external funds for these​ firms?

Loans from financial intermediaries

A student makes the following​ observation: It currently takes 80 yen to buy 1 U.S.​ dollar, which shows that the United States must be a much wealthier country than Japan. But it takes more than 1 U.S. dollar to buy 1 British​ pound, which shows that Great Britain must be a wealthier country than the United States. Do you agree with the​ student's reasoning?​ Why?

No, exchange rates do not measure the wealth of a country.

What is the difference between the nominal exchange rate and the real exchange​ rate?

Nominal exchange rates tell you how​ many, say, euros you will receive in exchange for a U.S.​ dollar, but they do not tell you how much of another​ country's goods and services you can buy with that U.S. dollar.

Suppose the First National Bank has $200 Million in assets and $20 Million in equity capital. If First National has a 2% ROA, what is its ROE? Now suppose First​ National's equity capital declines to $12 million, while its assets and ROA are unchanged. What is First​ National's ROE​ now?

ROE = ROA × (Bank assets/Bank Capital). In this case, ROE = 0.02 × ($200 million/$20 million) = 0.2, or 20% ROE = 0.02 × ($200 million/$10 million) = 0.4 or 40%.

From this​ perspective, why might there be too few bank failures as the result of deposit​ insurance?

Rather than let banks​ fail, the FDIC steps in to minimize the amount of money it will have to pay out.

The most important bank assets are

Real estate loans and U.S.​ government/agency securities.

How was Easterly able to tell that​ Brazil's currency was​ overvalued?

Since the price of U.S. goods in terms of the Brazilian currency was significantly lower than the price of the same items in Brazil.

The most important bank liabilities are

Small-denomination time deposits and Checkable deposits.

Suppose that​ Lena, who has an account at SunTrust​ Bank, writes a check for ​$150 to​ Jose, who has an account at National City Bank. Use following the​ T-account for SunTrust Bank to show how it is affected after the check clears. Use following the​ T-account for National City Bank to show how it is affected after the check clears.

SunTrust Bank Assets: Reserves (150) Liabilities: Checkable deposits (150) National City Bank Assets: Reserves 150 Liabilities: Checkable deposits 150

Why was TARP​ created?

TARP was created to restore the market for​ mortgage-backed securities and other toxic assets to provide relief to financial firms that held these assets on their balance sheets.

What effect has the SEC had on the level of asymmetric information in the U.S. financial​ system?

The SEC has been successful in reducing the cost of asymmetric​ information, but it has not eliminated it completely.

Which of the following is true regarding the Securities and Exchange Commission​ (SEC)?

The SEC is a federal government agency that regulates U.S. stock and bond markets.

Writing in the Wall Street Journal​, economist William Easterly of New York University notes​ that: "Around ​2010, ...the domestic currency in Brazil was so overvalued that tourists from Rio visiting Manhattan rented shipping containers to bring home their cheap purchases ...." ​Source: William​ Easterly, "Making Sense of ​Meltdowns," Wall Street Journal​, July​ 6, 2016. What does Easterly mean that​ Brazil's currency was​ overvalued?

The exchange rate for the​ Brazil's currency exceeds what the open market is willing to pay.

Economist Richard Sylla of New York University has argued that in the​ 1790s, Secretary of the Treasury Alexander Hamilton "established the financial foundations that would make the United States the most successful emerging market in the nineteenth​ century, and the economic colossus of the next that some would call the​ 'American ​century.'" ​Source: Richard​ Sylla, "Financial ​Foundations: Public​ Credit, the National​ Bank, and Securities ​Markets," in Douglas A. Irwin and Richard​ Sylla, eds., Founding​ Choices: American Economic Policy in the 1790s​, ​Chicago: University of Chicago​ Press, 2011, p. 86. Sylla would focus on all of the following "financial foundations" of the United​ States, except:

The issuance of currency.

How is it related to the theory of purchasing power parity​ (PPP)?

The law of one price is the basis for PPP.

An article on forbes.com during the​ Covid-19 pandemic noted​ that: "In the days and weeks after the pandemic​ hit, U.S. corporations drew on over​ $500 billion in​ credit, much of it from​ America's four biggest​ banks." The article also noted the​ "banks' strong capital and liquidity heading into the​ pandemic." Are the loans the banks made to corporations an asset or a liability to the banks doing the​ lending? Are they an asset or a liability to the firms borrowing the​ funds?

The loans are assets to the banks and liabilities to the corporations since the money must be paid back to the bank in the future.

Why is the supply curve for foreign exchange upward​ sloping?

The quantity of dollars supplied will increase as the exchange rate increases.

Which of the following reasons might explain why repealing the​ Glass-Steagall Act may have been a bad​ idea?

The repeal of​ Glass-Steagall increased the risk to the financial system.

In what ways are investment institutions similar to commercial​ banks? In what ways are they​ different?

They both borrow short and lend long. Investment institutions are different from commercial banks because they do not engage in traditional commercial banking​ activities, such as taking deposits and making loans.

What role do the GSEs play in the market for residential​ mortgages?

They buy mortgages from banks and sell mortgage backed securities to investors.

What is the most important source of funds for small to​ medium-sized firms?

The​ owners' personal funds and profits

Why​ don't these firms rely on external funds to the same extent as large firms​ do?

Transactions costs and information costs are much higher for smaller firms.

Which of the following is the most highly liquid asset found on a​ bank's balance​ sheet?

U.S. Treasury securities

Who would be interested in exchanging dollars for​ yen?

U.S. companies importing or buying Japanese products.

What is​ underwriting?

Underwriting is an activity in which an investment bank guarantees to the issuing corporation the price of a new security and then resells the security for a profit.

In what sense is an investment bank that engages in underwriting acting as a financial​ intermediary?

Underwriting is financial intermediation because the bank brings together savers and the issuers of securities.

What is the difference between retail and wholesale​ funding?

Using deposits to finance investments is called (retail) funding. Another source of funds is​ short-term borrowing primarily from other financial firms. This type of financing is called (wholesale) funding. (Investment) banks rely on wholesale funding of their investments as opposed to the retail funding that (Commercial) banks rely on.

The Apply the Concept states that certain developments that occurred during the 2020​ Covid-19 pandemic​ "had shifted adverse selection and moral hazard problems from GSEs back to​ mortgage-lending firms." How did this shift​ occur?

When Congress passed the CARES act they included a provision that (allowed a one year forbearance on mortgage payments). If banks originated and were holding the mortgage when this provision was enacted by the borrower then the loan (couldn't be sold to a GSE). This meant that for these mortgages (banks were stuck with the default risk).

A student makes the following​ observation: This month the euro depreciated sharply against the U.S. dollar. That was good news for attendance at Disneyland Paris and bad news for attendance at Walt Disney World in​ Orlando, Florida. Do you agree with the​ student?

Yes, as the euro​ depreciates, it becomes less expensive for U.S. citizens to travel to Disneyland Paris.

Suppose that the current exchange rate is €1.06=£​1, but it is expected to be €1.02=£1 in one year. If the current interest rate on a​ one-year government bond in the United Kingdom is 10​%, what does the​ interest-rate parity condition indicate the interest rate will be on a​ one-year government bond in​ Germany? Assume that there are no differences in​ risk, liquidity,​ taxation, or information costs between the bonds.

[.10+((1.02-1.06)/1.06)]x100%=6.23% The German interest rate will be 6.23​%

Loan sales is

a financial contract in which a bank agrees to sell the expected future returns from an underlying bank loan to a third party.

Standby letters of credit are

a promise by a bank to lend​ funds, if​ necessary, to the seller of commercial paper at the time that the commercial paper matures.

In July​ 2010, Congress was considering having the federal government set up a​ "lending fund" for small banks. The U.S. Treasury would lend the funds to banks. The more of the funds the banks loaned to small​ businesses, the lower the interest rate the Treasury would charge the banks on the loans. Congressman Walt Minnick of Idaho was asked to comment on whether the bill would be helpful to small businesses. Here is part of his​ response: ​"The bank​ that's struggling to write down their commercial real estate assets is having to take a hit to​ capital, and this provides replacement capital on​ very, very favorable terms. So it deals with the left side of the balance​ sheet..." Source​: Robb​ Mandelbaum, "Can Government Help Small​ Businesses?" New York Times​, July​ 29, 2010. a. Would a loan from the Treasury be counted as part of a​ bank's capital? b. Does a​ bank's capital appear on the left side of the​ bank's balance​ sheet?

a. No, a loan from the treasury would not be counted as bank capital. Your answer is correct. b. Bank capital appears on the right side of the balance​ sheet, because it is the difference between assets and liabilities. Your answer is correct.

Off-balance-sheet activities are

activities that do not affect a​ bank's balance sheet because they do not change either the​ bank's assets or its liabilities.

Trading activities are

activities that include trading in the​ futures, options, or swaps market.

A reader wrote to an advice column in the New York Times complaining that his insurance company canceled his​ homeowner's policy after he had filed two claims. The advice columnist discovered that "a lot of people have shared a version of​ [this man's] experience ... a couple of small claims ... then nonrenewal." By canceling these​ people's policies, insurance companies are attempting to avoid ________ _________. Why​ don't insurance companies just raise the annual premiums they charge instead of canceling​ policies?

adverse selection; Higher rates will attract riskier people to buy policies and discourage safer people.

How do banks manage credit​ risk?

all of the following apply Banks can manage credit risk by performing credit risk​ analysis, requiring borrowers to put up​ collateral, and using credit rationing. Banks can manage risk by creating​ long-term business relationships by which the bank could acquire information about the creditor. Banks can manage credit risk by diversifying their assets.

How do banks manage liquidity​ risk? ​(Check all that apply.​)

all of the following apply Banks manage this risk by keeping some funds very​ liquid, such as a reverse repurchase agreement. Your answer is correct. Banks can increase their borrowings to cover liquidity risk. Your answer is correct. Banks manage this risk by keeping some funds very​ liquid, such as in the federal funds market.

According to the theory of purchasing power​ parity, if the inflation rate in Japan is lower than the inflation rate in​ Canada, what should happen to the exchange rate between the Japanese yen and the Canadian dollar in the long​ run? In the long​ run, the Japanese yen will __________ relative to the Canadian dollar because of _____ inflation in Japan.

appreciate: lower

Loan commitment is

a​ bank's consent to provide a borrower with a stated amount of funds during some specified time.

With respect to the theory of purchasing power​ parity, the statistics in this table are If the purchasing power parity theory allowed us to exactly determine exchange rates in the short​ run, the exchange rate between the Israeli shekel and the Brazilian real would be _____ shekels per real.

both inconsistent since the domestic currency prices of Big Macs​ (for the​ non-U.S. countries), when converted into​ dollars, differ markedly from​ $4.33. and consistent since the domestic currency prices of Big Macs​ (for the​ non-U.S. countries), when converted into​ dollars, would not differ from​ $4.33 if transportation costs are included. Israel shekel price divided by Switzerland Swiss franc price 11.9/6.5=1.831

Consider the possibility of income insurance. With income​ insurance, if a person loses his job or​ doesn't get as big a raise as​ anticipated, he would be compensated under his insurance coverage. Why​ don't insurance companies offer income insurance of this​ type?

both apply The problem is adverse selection​ (people who are more likely to be fired or get low raises would be more likely to buy such​ insurance). and The problem is moral hazard​ (once insured, you​ won't work as​ hard).

The World​ Bank's data tells us that countries with higher levels of financial development tend to have ______ levels of real GDP per​ capita, which indicates they are ______ able to provide a high standard of living for their residents.

higher; better

The law of one price states​ that:

identical products should sell for the same price everywhere.

The SEC was founded

in 1934 in an attempt to alleviate the asymmetric information problem that became apparent following the stock market crash of 1929.

PPP is a _______ theory that generally only holds over a ____ period of time.

long-run; long

When a newspaper article uses the term​ "the exchange​ rate," it is typically referring to the _______ exchange rate.

nominal

Suppose that an Apple iPhone costs ​$200 in the United​ States, ​£70 in the United​ Kingdom, and ¥30,000 in Japan. If the exchange rate between the pound and the dollar is ​$1.50 ​= £1, the real exchange rate between the pound and the dollar is ___ . If the exchange rate between the dollar and the yen is ¥100 ​= $1, the real exchange rate between the dollar and the yen is ___.

real exchange rate (e) =Ex(Pu.k./Pu.s.) 1.50x(70/200)=.53 real exchange rate (e) =Ex(Pu.s./Pj) 100x(200/30,000)=.67

The​ "lemons problem"

refers to the adverse selection problem that arises from asymmetric information.

The FDIC stands for Why was it​ established?

the Federal Deposit Insurance Corporation. The FDIC was established to ameliorate bank runs. and The FDIC was established in 1934 after a series of bank failures.

Suppose that the current exchange rate between the yen and the dollar is ¥97=​$1 and that the interest rate is 5​% on a​ one-year bond in Japan and 4​% on a comparable bond in the United States. According to the​ interest-rate parity​ condition, what do investors expect the exchange rate between the yen and the dollar to be in one​ year?

the interest rate on domestic bonds = interest rate on foreign bond - expected appreciation of the domestic currency 5%-4%=1% 97x.01=.97 97+.97=97.97 The exchange rate will be ¥97.97=​$1. ​

The World Bank measures financial development​ by:

the total amount of credit banks and financial markets extend to households and firms as a percentage of GDP.

Did the federal government lose money from​ TARP? Briefly explain.

​No, TARP funds were invested heavily into bank stocks to increase bank capital. These holdings eventually made the government a profit.


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